Reconsidering the Relation Between Profit Efficiency and Noninterest Income

30 Pages Posted: 4 Jun 2021

See all articles by James E. McNulty

James E. McNulty

Florida Atlantic University

Bradley Stevenson

Bellarmine University

Date Written: May 27, 2021

Abstract

Profit efficiency is closely related to value creation, and researchers have found noninterest income to be a major determinant of profit efficiency. But DeYoung and Rice suggest that some banks have an excessive reliance on NII, pointing out that 1% of banks generate 18% of fee income, and that these are not the most profitable banks. Other studies support this view. This suggests that there is some optimal range of NII/Assets, and beyond that point bank profit efficiency declines. We test the hypothesis that NII reduces profit efficiency at some point and find no support for the hypothesis. Specifically, considering bank holding companies (BHCs) from 1996 through 2018, for all size groups, profit efficiency increases as NII increases. A significant source of NII for some BHCs is the provision of correspondent banking services, and these have been found to exhibit economies of scale. They have low variable cost once the correspondent relationship has been established (often many years in the past). This point helps explain the concentration of NII at a small number of banks and reconciles our results with others.

Keywords: Profit Efficiency, Noninterest Income, Stochastic Frontier Analysis, Correspondent Banking

JEL Classification: G21, D02

Suggested Citation

McNulty, James E. and Stevenson, Bradley, Reconsidering the Relation Between Profit Efficiency and Noninterest Income (May 27, 2021). Available at SSRN: https://ssrn.com/abstract=3855041 or http://dx.doi.org/10.2139/ssrn.3855041

James E. McNulty (Contact Author)

Florida Atlantic University ( email )

777 Glades Rd.
Boca Raton, FL 33341
United States
(561) 297-2708 (Phone)

Bradley Stevenson

Bellarmine University ( email )

2001 Newburg Rd
Louisville, KY 40250
United States
502-452-8173 (Phone)

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